- Estate planning practitioners regularly include some form of withdrawal rights in irrevocable trusts, exercisable with respect to a specific amount and for a limited period of time, to enable the trust’s donor to utilize his or her IRC Section 2503(b) annual exclusion from gift tax for contributions to the trust. The reason a withdrawal right must be included is to provide the beneficiary with a “present interest” in the gift.
- While the intended result of providing such withdrawal rights is always the same from a gift tax perspective, namely to ensure that the maximum amount of each contribution is not subject to gift tax, the methods used by practitioners to both create and administer withdrawal rights vary widely.
- In order to determine whether there is in fact one, definitive best practice to recommend to practitioners when administering withdrawal rights, the author reviewed the statutes, case law and rulings governing the use of withdrawal rights. For example, what actions must be taken by a donor and trustee to properly secure annual exclusion treatment for gifts to a trust? What actions are not required, but may be beneficial from an evidentiary perspective on audit? Is there a less burdensome alternative to the standard method of annual notice by mail that still meets the requirements? Can any actions by the donor or trustee actually compromise the intended gift tax result? This article endeavors to answer all of these questions.
II. Withdrawal Rights in General
- The purpose of providing a beneficiary of an irrevocable trust with a withdrawal right over contributions to the trust is to ensure that the property subject to such withdrawal right can be classified as a gift of a present interest, thereby allowing it to qualify for the “annual exclusion” from gift taxes under IRC Section 2503(b). That section provides that the first $10,000 (adjusted to $14,000 for calendar year 2016) of gifts of a present interest in property by a donor to a donee is excluded from the donor’s total taxable gifts made during the calendar year.
- A trust agreement with a typical “withdrawal right” provides that, whenever property is contributed to the trust, one or more trust beneficiaries (or a guardian or other person on behalf of a minor or incapacitated beneficiary) has a right to withdraw a portion of such contribution for a certain period of time. The trust agreement usually provides that the trustee must give the beneficiary timely notice of each contribution and notify the beneficiary of the amount subject to his or her withdrawal right. The amount subject to withdrawal by each beneficiary is generally capped at the annual exclusion amount, reduced by any previous gifts to that beneficiary by the donor within the same calendar year. If the beneficiary does not notify the trustee of his or her election to exercise the withdrawal right, the right to withdraw usually lapses after a period of time or at the end of the calendar year.
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